Posts Tagged 'bonds'

On Tuesday the 15th of March, Fifth and Sixth Year students took part in the Bond Trader Challenge run by the Bank of Ireland in the Harlequin Hotel. The evening began with an overview of markets and trading. Students then took part in the Bond Trader Challenge, responding to real market scenarios and making decisions on how to manage their own bond portfolio.

There has been a lot in the news recently about “bonds” and “bond yields”.

The following is an article from the Sunday Business Post that explains what these are.

What is a bond?

A bond is a unit of debt. The bonds we’re all talking about these days are sovereign bonds, or units of government debt. But companies sell them too.

It’s just a contract by which an investor agrees to loan money to a company or government in exchange for a predetermined interest rate and generally for a predetermined period of time (two years, five years, ten years).

Why is it bad when bonds rise?

When we say a bond has risen, we mean the yield – or interest rate – on that bond has risen. Effectively yields and prices move in the opposite direction. A rising bond yield is a falling bond price.

As yields rise, it indicates investors won’t buy that country’s debt unless they get a better return. The higher the level of risk they perceive to their investment , the higher the interest rate which investors demand.

Right now investors fear that if they lend to Italy they may eventually not get all their money back – so they are demanding a higher interest rate to compensate for this perceived risk.

Right. And seven per cent is a high yield is it?

Yes it’s very high, particularly when a German bond is yielding two per cent, which means investors want a five per cent premium from Italy (this is an enormous gap in sovereign debt terms).When yields in Ireland and Portugal hit that level, it was time for a bailout.

OK, so why doesn’t Italy just stop selling bonds for a while until it all blows over?

It might have to, but then it has to worry about how to pay its bills. It needs to repay some maturing bonds later this year and has to raise a hefty €300 billion in 2012.The EU/IMF could offer funds to Italy – but they probably do not have enough in the kitty to bail Italy out for a period of years, as they have done with Ireland, Greece and Portugal.

Last Tuesday, the Irish government borrowed another €1.5bn. You may have heard a lot about bonds in the news early this week. So what are bonds and why are they important to Ireland?

Bonds are used by the government to raise money. The Irish government needs to borrow about €20bn per annum in order to run the country i.e. our total expenditure exceeds our total income by €20,000m.

Each bond is usually sold for €100 and has a fixed rate of interest.

An example would be:

€100 4% April 2014

€100 is the price of the bond. The bond will pay 4% interest per year. This is a fixed rate. In April 2014, the bond “matures” i.e. the government repays the €100 to the investor who bought the bond.

The government is borrowing the €100 until April 2014 and pays 4% interest per year.

The reason why bonds were in the news this week is that Ireland now has to pay a higher interest rate to the people who buy our bonds because they view Ireland as more of a risk i.e. will we be able to pay the interest each year and the €100 in 2014?

This is the same as a bank would do when lending money to a risky customer i.e. charge them a higher interest rate.